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Central bankers are trained and armed to fight inflation. However, the enemy, if not routed, seems to have taken to the hills.

Headline consumer price inflation has averaged 1 per cent over the past five years, right at the bottom of the Reserve Bank's target band.

And with a pretty flat yield curve — 10-year government stock is trading at a yield of around 2.8 per cent — the financial markets seem sanguine about the inflation outlook too.

In a speech this week, acting governor Grant Spencer acknowledged that at least since the global financial crisis, the bank's economic models, grounded in past experience, keep forecasting a rise in non-tradables inflation and it keeps not happening.

It is not just a local issue. Low inflation has persisted in most advanced economies despite falling unemployment and what is extremely loose monetary policy, by historical standards.

The usual story about this, which Spencer endorses, highlights the twin effects of globalisation and digital technology.

Over the past 20 years or so, billions of people have been added to the global economy and global trading system, who previously would have been part of some rural village economy of little interest to anyone else. Mainly, but not only, in China and willing to work for a fraction of what people in the West need to be paid. One consequence is that prices of internationally traded manufactured goods have fallen.

In addition, China's growth model has included investing heavily in industries such as steel and aluminium, contributing to a global overcapacity which depresses prices.

Meanwhile, advances in information and communications technology have seen not only an astonishing increase in bang for the consumer's buck when buying computers or phones, but also, as Spencer points out, lowered barriers to entry across a whole range of markets. Hello Amazon!

Meanwhile on the domestic or non-tradables side, central bankers, not just here but elsewhere, have been perplexed by a flattening of the Phillips curve.

Devised by the New Zealand economist Bill Phillips in the late 1950s, it relates inflation to measures of slack or spare capacity in the economy, such as unemployment. The greater the slack, the weaker the inflation pressure.

Spencer put up a chart showing that while the (inverse) correlation between unemployment and inflation held good between 2001 and 2011, since then it has broken down.

In one sense this is convenient for the Reserve Bank, if it continues.

As the new Government intends to amend the Reserve Bank Act to give it a dual mandate, with maximising employment to sit alongside price stability, it will be helpful if there is not a seesaw relationship between unemployment and inflation. If there was, that could raise the dilemma of which end to put the heavier kid on when making monetary policy decisions.

But Spencer is not convinced this is a permanent change. "We have not yet observed how wages and prices respond to a very tight capacity situation."

The picture is complicated by immigration. "There is not much doubt that an increase in international labour mobility has also affected wage inflation in New Zealand," Spencer said.

"In some of the traditional non-traded sectors like construction there is now greater scope for employers to meet skill shortages through international hires, even though recent stretch in the construction industry has seen wage costs increasing for certain occupations and skills.

"On a national scale, we have experienced ongoing high levels of inward migration. Over the past three years, the population has grown by around 6 per cent, of which less than a third is from natural growth. An increasing share of the inward migration has been on work visas, thus contributing to higher productive capacity."

In addition, economists have long recognised that any Phillips curve in their models has to be modified by inflation expectations. "If firms and workers expect higher inflation to result from current capacity pressures, they will more quickly bid up prices and wages," Spencer said.

The absence of that behaviour suggests — and Reserve Bank research has confirmed — that in an environment where inflation has been low for some time, businesses have been placing greater weight on past inflation in setting prices.

That also tends to keep inflation low and contributes to a flattening of the Phillips curve.

Faced with all this, what should the Reserve Bank do?

First of all, not worry too much if low or negative imported inflation keeps the headline rate below the 2 per cent mid-point of its target band. Its price stability mandate is flexible enough to allow it not to try to fully offset weak tradables inflation by goosing the domestic economy more than it already has.

if inflation has become less responsive to monetary policy, the central bank should not react by getting more heavy footed and aggressive.

After all, there are some serious negative side effects to persistently low interest rates in terms of asset (house) price inflation and a potentially toxic build-up of household debt.

Last month's monetary policy statement forecasts non-tradables inflation to pick up from late next year in response to mounting capacity pressures. But it has been wrong about this before.

"If this response does not eventuate, then we would have to consider a further easing of policy to generate additional domestic demand pressure, particularly if global inflation remains low in line with our forecast," Spencer said.

But then he added an important caveat: "However we would need to be careful not to generate unwarranted instability in output, the exchange rate or indeed household debt."

To paraphrase: if inflation has become less responsive to monetary policy, the central bank should not react by getting more heavy footed and aggressive. It can afford to be patient and remember that economic stabilisation is about more than just inflation.

"It may be appropriate to put relatively more weight on output, employment and financial stability relative to inflation."

Orthodoxy seems to be moving in this direction. Claudio Borio, chief economist at the central banks' umbrella organisation, the Bank for International Settlements, concluded a recent lecture on these issues by highlighting "the desirability of greater tolerance for deviations of inflation from point targets, while putting more weight on financial stability."